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Could the strengthening USD trigger a financial crisis?

Dysfunction, disorderly, crisis, financial shock. These are not the words investors want to hear, but they are increasingly on the minds of some economists,…

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Dysfunction, disorderly, crisis, financial shock. These are not the words investors want to hear, but they are increasingly on the minds of some economists, analysts and investors.  So, what factors have led to such a negative outlook?

It begins with everything we have written about here at the blog already. The U.S. Federal Reserve has been playing ‘catch-up’, raising rates faster than others, and at a pace unseen in decades. Additionally, the U.S. central bank has adopted a policy of balance sheet reduction, also known as QT (Quantitative Tightening), which involves allowing the bonds it has previously purchased to mature without replacing them, and which has a similar effect to rate tightening albeit further out along the yield curve.

It’s all part of that central bank’s plan to get their balance sheet down and the U.S. dollar up.  And it’s worked. Figure 1 reveals the resultant dispersion between the U.S. dollar and its main trading cross currencies.

Figure 1. USD Performance

For many, there’s safety in owning U.S. dollars because the Federal Reserve’s Chairman, Jerome Powell, has repeated the refrain the bank will uphold its forceful stance, and “keep at it” until inflation has been tamed.

The global consequence of U.S. dollar strength is currency cross-rate weakness. The weaker currencies effectively paint the U.S. as the exporter of inflation. And some analysts believe this raises the threat of default, especially by those developing countries with large dollar-denominated debt balances. According to the United Nations (UN), 90 per cent of emerging market debt is denominated in U.S. dollars, so a stronger USD renders repayments punitive. Meanwhile, global debt levels reached a 50-year high following government fiscal initiatives to support society during the pandemic. 

In May 2022, Sri Lanka – considered a middle-income country – defaulted on its debt for the first time. The country’s government was given a 30-day grace period to cover $78 million in unpaid interest but ultimately failed to pay, amid heaving inflation spurred by the collapse of its currency.

Indeed, a record number of developing countries are now in difficulty if the measure is a combination of collapsing currencies, bond spreads blowing out beyond 1,000 points, and torched FX reserves. Joining Sri Lanka for example are Lebanon, Russia, Suriname, and Zambia. The International Monetary Fund (IMF) now estimates almost a third of emerging market countries and 60 per cent of low-income countries could face trouble paying down their debts or will soon.

Rising borrowing costs, inflation, and debt all fuel concerns of an economic collapse for many countries. The UN has called for debt relief for 54 developing economies it has identified as experiencing severe debt problems. And while these countries account for just over three per cent of the global economy, they represent 18 per cent of the global population and over half of those living in extreme poverty.

The idea of a financial crisis has raised its head in developed markets because it was until now thought the debt default issue and corresponding bond market volatility was contained within developing countries. Huge swings such as those experienced by the UK Gilt market in late September typically don’t happen to the sovereign debt markets of developed countries. 

In the recent UK episode, thanks in no small part to the plunge in Cable (British Pound/USD) amid fiscal irresponsibility, the 30-year Gilt yield rose by 160 basis points in just four sessions and then collapsed by 400 basis points in one. As recently as the week before last, the Bank of England was expanding its bond buying program despite the fact it is scheduled to end at the end of this week.

The uncertainty for many, and the very real financial pain for many more, is understandably causing concerns and associated volatility.

Watch this space.

You can read other thoughts on the USD in this article:
WHAT WILL ROAR WHEN THE USD EVENTUALLY REVERSES?

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Highlights of My Weekly Reading and Viewing

Timothy Taylor, “Some Economics of Pharmacy Benefit Managers,” The Conversable Economist, September 28, 2023. This is the nicest treatment of the facts…

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October 1, 2023

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Timothy Taylor, “Some Economics of Pharmacy Benefit Managers,” The Conversable Economist, September 28, 2023. This is the nicest treatment of the facts that I’ve seen. I confess that I’ve seen PBMs as something of a black box rather than doing the standard middleman treatment that Tim does.

Tim highlights the work of Matthew Fiedler, Loren Adler, and Richard G. Frank in “A Brief Look at Key Debates About Pharmacy Benefit Manufacturers,” Brookings Institution, September 7, 2023.

Ending paragraph:

As in most economic discussions about the role of middlemen, it’s important to remember that they (usually) don’t just sit around with their hands out, collecting money. Some entity needs to negotiate on behalf of health insurance companies with drug manufacturers and pharmacies. Some entity needs to process insurance claims for drug prices. I do not mean to defend the relatively high drug prices paid by American consumers compared to international markets, nor to defend the costs and requirements for developing new drugs, nor to defend some of the mechanisms used by drug companies to keep prices high. But while it might be possible to squeeze some money out of PBMs for slightly lower drug prices, and it’s certainly possible to mess up PBMs in a way that leads to higher drug prices, it doesn’t seem plausible that reform of PBMs is going to be a powerful lever for reducing drug prices.

Thomas W. Hazlett, “Maybe Google Is Popular Because It’s Good,” Reason, September 27, 2023. I think Hazlett is the best writer in economics. This piece is a good sample.

An excerpt:

The innovation was simple in design, complex in execution, and radical in result. The business achieved a rare triple play: First, a robust new web crawler devised a superior method for finding and tagging the world’s digital content, deploying cheap PCs linked in formations to achieve momentous computing power (Brin’s genius). Second, this more prolific database of global digital content was better cataloged. A clever “Page Rank” score evaluated keyword matches, countering the influence of scammers by scrutinizing the quality of their web page links (Page’s inspiration). Third, “intention-based advertising” displayed commercial messages to searchers self-identified as ready to buy. For instance, the internet user wondering about “coho salmon, Ketchikan, kids” gave Hank’s Family Fishing B&B in Alaska a digital target for its 10 percent off coupon, while signaling to Olay not to bother advertising its skin care products. This solved the famous marketing dilemma: “I know I’m wasting half my ad budget, I just don’t know which half.” Businesses loved these tiny slices of digital real estate, and Google mined gold.

Fiona Harrigan, “America’s Immigrant Brain Drain,” Reason, October 2023.

Excerpt:

In June, The Hechinger Report outlined how foreign governments are welcoming U.S.-trained international students. The United Kingdom offers a “high potential individual” visa, which authorizes a two-year stay and is available to “new graduates of 40 universities….21 of them in the United States.” Recruiters from Australia are “attending job fairs and visiting university campuses” in the United States. From 2017 to 2021, according to the Niskanen Center, a Washington-based think tank, Canada managed to attract almost 40,000 foreign-born graduates of American universities.

Most international students want to stay in the U.S. after graduating, but very few are able to do so. The U.S. does not have a dedicated postgraduate work visa. Canada and Australia, meanwhile, have streamlined the steps from graduation to employment to permanent residency. Graduates in the U.S. can complete Optional Practical Training, but it does not lead to permanent residency and lasts a maximum of three years.

Personal note: Actually the maximum of 3 years for Practical Training sounds good. When I took advantage of the F-1 Practical Training visa to be on the faculty of the University of Rochester, the max was only 18 months.

David Friedman, “Consequences of Climate Change,” September 24, 2023. David does his typical calm, clear, masterful job of laying out the facts. He takes the IPCC reports as given and then follows the implications, uncovering a lot of misleading claims in the process. While David takes as given that the earth will heat about another degree centigrade by about the end of the century, he lays out why we can’t be sure that the net effects are negative or positive. Watch about the first 35 minutes of his speech, before he gets to Q&A. I would point out highlights but there is zinger after zinger. And he references his blog and his substack where you can get details.

The pic above is of David Friedman giving his talk.

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Russia’s Military Budget Set To Rise By 70%

Russia’s Military Budget Set To Rise By 70%

Via Remix News,

Russian military spending is set to rise by almost 70 percent — to €106…

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October 1, 2023

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Russia's Military Budget Set To Rise By 70%

Via Remix News,

Russian military spending is set to rise by almost 70 percent — to €106 billion — by 2024, according to a Russian Finance Ministry document published Thursday, an increase that illustrates Moscow’s determination to continue its military intervention in Ukraine despite the human and economic costs.

According to the document, Russian defense spending will increase by 68 percent in 2024 compared to this year and will reach 10.8 trillion rubles (€106 billion).

As a result, the amount allocated to defense will represent about 30 percent of total federal spending in 2024 and 6 percent of GDP — a first in Russia’s modern history.

The budget for internal security is set to rise to 3.4 trillion rubles (€33 billion), almost 10 percent of annual federal spending.

The priorities for this budget are outlined as “strengthening the country’s defense capacity” and “integrating the new regions” of Ukraine whose annexation Moscow has demanded, as well as “social aid for the most vulnerable citizens,” just months ahead of the Russian presidential elections in spring 2024.

Conversely, total spending on education, healthcare and environmental protection accounts for barely a third of the defense budget, according to ministry figures. Overall, federal spending will total 36.7 trillion rubles (€359 billion), a dramatic 20 percent increase over 2023.

The government, however, has explained little about how it will finance this large increase, as Russian Prime Minister Mikhail Musustin said last Friday that revenues from the sale of hydrocarbons will be down sharply and will account for “a third of next year’s budget” in 2024, whereas before the invasion of Ukraine, they accounted for half the budget.

The sector used to drive Russia’s growth, hydrocarbon sales are declining due to international sanctions and the European Union’s determination to move away from energy dependence on Moscow.

One indication that the government expects a delicate month ahead for the Russian economy is that it has announced that it has based its budget forecast on the assumption of a dollar worth around 90 rubles, thus betting on a weakening of the national currency in the medium term. The draft budget law for 2024-2026 is due to be sent to the State Duma, Russia’s lower house of parliament, on Friday.

Tyler Durden Sun, 10/01/2023 - 08:10

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Atlantic Overfishing: Europe’s Worst Offenders

Atlantic Overfishing: Europe’s Worst Offenders

Each year, agriculture and fisheries ministers decide on total allowable catches (TACs) for…

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October 1, 2023

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Atlantic Overfishing: Europe's Worst Offenders

Each year, agriculture and fisheries ministers decide on total allowable catches (TACs) for commercial fishing.

Scientific bodies, such as the International Council for the Exploration of the Sea (ICES), provide information on the state of fish stocks around the world and recommend maximum catch levels per zone to ensure sustainable fishing.

However, this scientific advice is all too often ignored by the authorities, jeopardizing the sustainability of marine resources.

Statista's Martin Armstrong shows in the following infographic, based on the latest report from the New Economics Foundation, these European countries are the worst offenders for this, having on numerous occasions set their fishing quotas in the North-East Atlantic in excess of the sustainability recommendations in recent years.

You will find more infographics at Statista

Sweden exceeded its recommended TAC by almost 33 percent in 2020 (the latest year available), equivalent to 12,000 tonnes of fish, followed by Denmark (6 percent, 20,000 tonnes) and France (6 percent, 17,000 tonnes).

Ireland, Belgium, Spain and the UK all exceeded their targets by between 2 and 4 percent.

The year before, in 2019, the overshoot of the sustainable fishing threshold in the zone was even more pronounced: 7 percent of the recommended TAC for Spain, 9 percent for France, 10 percent for Belgium, 18 percent for Germany, 20 percent or more for Denmark, the United Kingdom and Ireland, and 52% for Sweden.

Tyler Durden Sun, 10/01/2023 - 07:35

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